A Test of Strength for Gold

When investing in gold, I often say diverse opinions promote critical thinking
and a healthy market. I believe elevated groups of buyers and sellers create
a competitive tug-of-war in the bid and ask price of the precious metal.

Last week, we saw the gold bears growling louder and gaining strength, as
the world's largest gold-backed ETF, the SPDR Gold Trust, experienced its largest
one-day outflows since August 2011. The Fear Trade fled the sector following
the Federal Reserve's meeting that revealed a growing dissension among some
of its members over the central bank's bond-buying program.

Despite the discord, the Fed is continuing its course to purchase $85 billion
of bonds every month and keep interest rates near zero. Ben Bernanke's plan
bloating the balance sheet to more than $3 trillion has been keeping the Fear
Trade coming back for more metal.

For good reason, too, as the correlation between the Fed's balance sheet and
the price of gold has historically been very high, at 0.93, according to Macquarie
Research. The firm found that for every $300 billion expansion in the balance
sheet of the U.S. government, there was a $100 an ounce increase in the price
of gold. When you factor in the Fed's current bond purchases totaling $85 billion
per month for the next nine months, the central bank will be adding $765 billion
in new assets. "Using the previous ratio, this would compute to a $255 an ounce
increase in the gold price," says Macquarie. By this measure alone, gold would
rise approximately 16 percent over the next several months.

On Bloomberg's Taking Stock with Pimm Fox on February 22, I said that Bernanke
will likely keep liquidity high for quite some time, in his effort to meet
his goal of lowering the unemployment rate. If the Fed did take its foot off
the bond-buying pedal sooner than planned, such a move is apt to shake the
resolve of some gold buyers. It's easy to be confident in gold in times of
extreme fear; when the economy improves, one may no longer feel that gold stands
on solid ground.

Take another period characterized by extreme volatility and fear, when there
was conflict in the Middle East, oil-related inflation shocks, declining value
in the U.S. dollar, rising U.S. unemployment and a strong resolve from the
Fed to act aggressively. This was four decades ago, after President Richard
Nixon removed the gold standard, and the yellow metal climbed to a peak of
$850 by January 1980.

Back then, India and China had little financial footing in global markets;
gold demand from these areas of the world was about 15 percent of total demand.

Since then, we've seen a rapid increase in GDP and incomes, resulting in a
dramatic rise in gold demand. According to the World Gold Council (WGC), there's
now an "increasing relevance of emerging markets in the gold market, particularly
over the past 12 years." In 2011, you can see that emerging markets accounted
for 74 percent of total bar and coin, jewelry and ETFs gold demand. India and
China alone make up 50 percent, and together with Turkey, Vietnam, and Southeast
Asia, these countries' residents clearly "have a cultural affinity to gold," says
the WGC.

To help investors analyze whether gold continues to be a wise investment,
I like to refer to the book The Wisdom of Crowds by James Surowiecki.
There are four factors to consider whether a crowd is suffering from groupthink
or is making wise decisions:

Ultimately, the key to gold is moderation. As I said in my book, The
Goldwatcher, and often reiterate to investors when I speak at conferences,
gold is a volatile asset class and the daily price can be more dramatic
than blue-chip stocks. We have always advocated that investors hold a modest
5 to 10 percent weighting in gold and gold stocks. In other words, we feel
strongly that an investor should not try to get rich from the metal.

Marc Faber expressed a similar idea in February's Gloom Boom and Doom Market
Commentary. Instead of selling his gold when the price is falling and buying
it back at a lower price, he says he doesn't stray from his asset allocation
approach. He holds a 25 percent allocation to gold, which is much higher than
we recommend, and believes that if the price of gold declined, it is likely
that his financial assets would increase.

In his closing, Faber reminds readers of the English Proverb: "When we have
gold, we are in fear; When we have none, we are in danger." If the proverb
were written today, it might be revised to say, "When we have gold, we are
in love."

Frank Holmes is CEO and chief investment officer of U.S. Global Investors,
Inc., which manages a diversified family of mutual funds and hedge funds specializing
in natural resources, emerging markets and infrastructure.

The company's funds have earned more than two dozen Lipper Fund Awards and
certificates since 2000. The Global Resources Fund (PSPFX) was Lipper's top-performing
global natural resources fund in 2010. In 2009, the World Precious Minerals
Fund (UNWPX) was Lipper's top-performing gold fund, the second time in four
years for that achievement. In addition, both funds received 2007 and 2008
Lipper Fund Awards as the best overall funds in their respective categories.

Mr. Holmes was 2006 mining fund manager of the year for Mining Journal, a
leading publication for the global resources industry, and he is co-author
of "The Goldwatcher: Demystifying Gold Investing."

He is also an advisor to the International Crisis Group, which works to resolve
global conflict, and the William J. Clinton Foundation on sustainable development
in nations with resource-based economies.

Mr. Holmes is a much-sought-after conference speaker and a regular commentator
on financial television. He has been profiled by Fortune, Barron's, The Financial
Times and other publications.

Please consider carefully a fund's investment objectives, risks, charges and
expenses. For this and other important information, obtain a fund prospectus
by visiting www.usfunds.com or by calling
1-800-US-FUNDS (1-800-873-8637). Read it carefully before investing. Distributed
by U.S. Global Brokerage, Inc.